Small Investors Flash Warning Sign

Stories like these – “Return of the daytrader: can you earn a living by copying other investors?” which the Telegraph ran on Saturday – are priceless:

It promises an irresistible combination of wealth and independence. All you need is a computer and an internet connection – and then you can earn a fortune from the comfort of your home.

This is the lure of financial trading for profit. As the popular BBC programme Millions by the Minute has shown, the dream seems to be gaining hold. It appeals to parents who hope to be able to squeeze in some profitable trading between school runs. And it is equally a way out for those who simply don’t want – or don’t fit into – the corporate world of the office.

Now the world of social media has added an additional, attractive twist to the dream of being your own boss and making a killing. With “copy trading” – which enables you to mimic the investment moves of the “professionals” – you can supposedly cash in even if you know nothing at all about the markets.

The fact that this day-trading theme – the idea that anyone can just shuffle stocks around for a living – is showing up on public television, even in the UK, that companies see an opportunity to make money off these folks, and that big newspapers like the Telegraph report on it, even if tongue in cheek – that’s like so January 2000.

There are many parallels today to the zaniest days of the dotcom bubble, but this time, it’s different: it has a darker hue – particularly concerning retail investors.

The Wells Fargo/Gallup Investor Optimism Index, released on Friday, jumped 17 points to +46, the highest level since fall 2007. That was the time when the US was teetering on the Great Recession and the Financial Crisis. It was the time just before all heck broke loose.

But these exuberant respondents are not investment pros on Wall Street, or wealth managers, or big investors. These are people with $10,000 or more in stocks, bonds, mutual funds, or in a self-directed IRA or 401(k). So not the entire American public but only those who have a stake (if a small one) in the markets. The results are based on interviews with 1,011 of these folks, 374 retirees, 631 non-retirees, and 6 people who I would guess checked “neither.”

So how knowledgeable about the markets are these exuberant folks? Turns out, these are the same kind of folks, based on the same selection criteria, who in a Wells Fargo/Gallup poll in August had mostly no clue how the stock market did last year.

They were asked a simple questions: “As far as you know, how did US stocks perform on average in 2013 – did they increase in value, stay about the same, or decrease?” If they chose “increase, they “could pick 10%, 20%, 30%, 40%, or 50%.

It so happened that 2013 was a special year. The S&P 500 chalked up a total return, including dividends, of over 32%, the most phenomenal performance since 1997. So not exactly a common event. These retail investors should have noticed. But they didn’t. The bulge bracket (37%) figured that stocks had gained 10%, while 21% thought stocks had remained flat, and 9% thought stocks had declined. Only 7% got it right.

These folks are now finally the most optimistic since 2007.

But this time it is different. At the peak of retail-investor and day-trader mania during the dotcom bubble in January 2000 before their brokerage accounts got cleaned out, the index hit 178, before plunging to 50 by mid-2001. In early 2002, the index climbed to back to 121, only to plunge to 5 a year later. By the end of 2003, it recovered to 108, dropped to 34 in 2005, and rose to 103 in early 2007. It then entered what at first looked like its habitual plunge. Only this time, it didn’t stop and just continued plunging until early 2009, when it bottomed out at -64.

Since the optimism peak in January 2000, small investors have consistently gotten fleeced, buying during the late stages of the run-up when their optimism surges, and selling when their pessimism plumbed new depth near the bottom of each downturn.

Each time, their optimism got whacked a bit more. And after each recovery, their peak optimism was weaker than before. It’s a downward slope of lower lows and lower highs. But what is still missing in this scenario is the next major downturn, and how, after it cleans out the brokerage accounts of these retail investors, it will decimate even further their long-run optimism about investments.

If this downturn grows into a crash, it will be for many retail investors the third crash in their investing lives; and for middle-aged retail investors, it will be the fourth crash. Confidence and optimism about stocks might go the same route that it went with retail investors in Japan – where it went completely to heck.

Post navigation

2 comments for “Small Investors Flash Warning Sign”

I’m happy to sit on the sidelines of this stock market rally. The entire thing is fake and based on no real sound fundamentals. Then again, what part of the world is actually doing well right now?

VegasBob

Sep 29, 2014 at 11:24 am

I’m primarily a bond investor, though I’ve dabbled in stocks over the years.

I thought the stock market rally of 2013 was utter insanity, especially in the face of rising interest rates which Benocchio touched off in May 2013 by raising the specter of “tapering” the Fed’s money-printing. As 2014 began, rates started falling again but they switched course and began to rise at the beginning of September. After a little trepidation in January, stocks started marching higher again in February. Now it finally looks like a few people are waking up and realizing that stocks are indeed a grossly overvalued bubble waiting for a pinprick.

One thing I am sure about is that the stock market is grossly overvalued and needs to plunge by 40 to 65% before it will represent anything resembling reasonable value for the risk involved.

Here is the ultimate irony for me, a bond investor.

California priced a sizable municipal bond offering on September 19, with 30 year bonds offering a paltry yield of about 3.85%. So I passed. I figured it was utter foolishness to take 3.85% for 30 years. Yet, that offering was oversubscribed so there were no leftover bonds to buy were I to change my mind.

Now, watching the market action of the past week, I’m wondering whether I made a mistake or not. Interest rates are doing exactly what they did the last time the Fed ended one of its money-printing schemes – rates are now dropping. Maybe that 3.85% yield was as good as it’s going to get for a few years and maybe I should have bought into that California municipal offering.